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The inflation-deflation debate has been raging
lately, yet no one really knows how it's going to unfold.
The reason for this is because we're seeing signs of both
inflation and deflation in the world, and in the markets today.
Why is this so important? It's important for a number of
reasons like your lifestyle, job, savings, retirement, world
politics, crime, social unrest and especially investments.
That's why we feel it's important to keep the big picture
in mind at all times. So if we stand back and look at the
biggest forces that are shaping, and will continue to shape
our world, along with the effects these forces will have,
we'd have to say it's China, terrorism and changing weather
patterns. Let's start with China…
CHINA POWER
After years of slumber, the world's oldest civilization is
now on its way to superpower status. In less than 20 years,
China has transformed itself from a basically agricultural
economy to the second largest economy in the world and the
fastest growing one. It's become manufacturer to the world
and by exporting these goods, China is building up huge surpluses
which it's using to invest in countries worldwide. China is
our second biggest lender and thanks in large part to China,
the U.S. has been living beyond its means and going deeper
into debt. In essence, this has amounted to a massive transfer
of wealth.
Meanwhile, China's economy is growing at an annual pace of
about 9% and this has been going on for many years. In contrast,
the U.S. economy slowed to 3.1%, hindered by its record trade
deficit, primarily with China. And there's no sign this will
end soon.
With a population four times larger than the U.S., China
needs to create more jobs and it'll likely keep doing this
because textile restrictions were lifted last month. Since
Chinese wages are so low compared to other countries, it's
estimated that about 30 million jobs will be transferred to
China from other countries and this mega trend is going to
continue.
How will this affect us? Aside from job losses and ongoing
deficits, there's much more involved. A major world economic
shift is taking place and if we go back in history as Marc
Faber does so well by saying that China compared to the U.S.
is very similar to the position of the U.S. compared to Great
Britain at the end of the 19th century.
At that time, the entry of the U.S. into the global economy
badly disrupted the economies of Western Europe as the U.S.
was rising and Britain was slowly loosing its superpower status.
The same thing is happening today. The entrance of China into
the global economy will have a negative impact on the standard
of living in the West, as we're seeing with employment, as
China's standard of living continues to improve.
In addition, China needs everything to continue building
its infrastructure. This has been one of the big factors keeping
upward pressure on the oil price, commodities and metals.
And it looks like this demand will keep pushing prices higher.
COMMODITIES MEGA TREND: Has turned up
Looking at the truly big 200 year picture of
commodity prices from 1804 to 2004, you can see that all commodities
generally move together (see Chart 1). There have been five
major upmoves since 1804 and we're just beginning the sixth.
This strongly suggests commodity prices will be rising for
years to come, which would coincide with China's growth and
ongoing demand.
But it's not only China. There are now three billion people
in the world economy who weren't there before when we consider
the emergence of India and the former communist countries,
in addition to China. As these people become more affluent
they'll be buying more oil for their cars, metals for their
industries and infrastructure, and food, which will keep upward
pressure on commodity prices. So looking out to the years
ahead, this is going to be inflationary.
Also interesting, these big commodity price rises have always
coincided with major wars throughout history. And the current
rise will probably coincide with the war on terror. In other
words, wars and/or geopolitical tensions will likely increase
in the years ahead.
DELICATE WORLD OF OIL
This shouldn't really come as a surprise. Despite the successful
election in Iraq, Bin Laden has stated many times he's out
to destroy the U.S. economically. He wants the U.S. and royal
family out of Saudi Arabia and he's been telling his followers,
which are growing in numbers, to attack oil fields and halt
supplies, which are essential to Western economies.
U.S oil imports are at record levels and the U.S. uses more
oil than Germany, Russia, China, Japan and India combined.
Saudi Arabia is one of our biggest oil suppliers and this
alone makes the entire oil picture vulnerable. Even though
it's hard to imagine because we tend to take oil for granted,
it's a threat that could not only cripple our economy but
intensify the war on terror if anything were to happen to
disrupt our oil supplies. It would also drive the oil price
up to unprecedented levels, which would tie in with this new
mega rise in commodity prices. For now, we don't know what's
going to happen, but somehow rising oil seems like it'll be
part of the equation.
CHANGING WEATHER
At the same time, modern society and our dependence on oil
has led to the worst weather disruptions in 1,000 years. This
is resulting in more disasters like floods, hurricanes and
droughts. Here again, as this continues in the years ahead,
crops will be damaged and in more demand, which will also
drive commodity prices higher.
That's the way we currently see it. This could change but
until we see evidence to the contrary, we feel there's a greater
likelihood inflation is in our future rather than deflation
and that should prove to be good for the metals and commodities
prices.
Interestingly, this commodity mega trend is
coinciding with the new investment era that began in the late
1990s with a shift out of financial assets like stocks, into
tangible assets like gold (see Chart 2).
STOCKS TOO HIGH VERSUS
GOLD
This chart compares the Dow Industrials to gold. You can see
that since 1919 there have been two major cycles and we're
currently into the third. When this ratio rises, the percentage
gains are better in stocks compared to gold and when it declines,
gold is the winning investment.
Note, for instance, stocks were better in the 1920s, 1950s-1960s
and 1980s-1990s. Gold was better in the early 1930s, 1970s
and now. This mega trend is telling us gold is where our investment
focus should be, not stocks at this time.
Also interesting, the lows in the ratio have occurred below
2. This also indicates stocks are still expensive and gold
is cheap with the ratio now near 25. This means that somewhere
ahead, and it'll likely take years, this ratio will probably
again get to near 2, which will happen as gold rises and stocks
fall. But either way, the ratio suggests the rises and declines
are going to be dramatic.
Coming back to what's happening now, gold's intermediate
decline that started in December is coming to an end. And
if gold can now stay above $421, a renewed rise will be underway.
This is now providing a good opportunity to buy new positions
looking out to the months ahead and to the long-term.
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